Development of private credit market as a growth driver

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Development of private credit market as a growth driver

Friday, April 27, 2018

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The Jamaican economy has witnessed a remarkable reduction in the Government's crowding out of the private sector, as the country's debt ratio has plummeted from a high of 145 per cent in fiscal 2013/14 to 105 per cent projected for the end of fiscal 2018/19.

A consequence of this reduced crowding out is the reduction in interest rates to historically low levels and increased corporate activity in the local capital markets, as evidenced by higher equity (initial public offerings and preference shares) and debt (corporate bonds) issuance.

As the Jamaican economy continues to evolve in its search for consistently higher levels of growth, the primary role of the local capital markets will be to provide a diversified pool of risk capital to businesses and entrepreneurs to pursue a broader set of growth opportunities.

In this regard, one of the fastest-growing sources of global financing, known as private credit, represents an important source of capital to stimulate economic activity.

The size of the global private credit market has grown fifteenfold since 2000 to US$640 billion in 2017 and is on course to hit US$1 trillion by 2020. The industry's growth underscores the increasing influence private credit is having on financing more developed economies.

The global private credit industry is now financing businesses at record levels, creating jobs and supporting economic growth around the world. Of particular note, more than 40 per cent of all private credit financing goes to small- and medium-sized firms, versus 19 per cent for large companies.

WHAT IS PRIVATE CREDIT?

Private credit is a non-traditional form of financing and is credit that is extended to businesses or projects on a bilaterally negotiated basis. It is typically originated or held by non-traditional financing firms (non-banks) and, unlike many corporate bonds, is not generally traded in a public market.

It may take various legal forms including notes, bonds,

asset-backed debt, preference shares with profit sharing, mezzanine debt and other forms of structured financing.

In a typical corporate structure, private credit represents financing that sits just below bank debt (normally senior debt), but above equity financing. Thus, in essence, private credit complements traditional bank debt by providing more flexible financing terms to fund businesses, thus increasing the velocity of economic growth.

WHAT ARE PRIVATE CREDIT FIRMS?

The typical private credit firm is made up of industry professionals with decades of investment banking, corporate credit, private equity, hedge fund or traditional asset management career backgrounds. Their expertise and knowledge of credit and investment markets usually lead them to develop businesses tailored to provide financing to the economy, targeting a niche, such as medium-sized firms.

These firms typically raise equity capital and use the proceeds to invest in companies using various credit instruments.

ADVANTAGES OF PRIVATE CREDIT

Private credit firms typically use a flexible approach to partner closely with businesses to understand and tailor financing solutions to meet specific objectives including acquisitions, refinancing, capital for growth, leveraged buyouts, and other highly customised objectives.

The key attractions of private credit are flexibility and customisation of financing terms, providing access to long-term capital (non-bank), quick decision making, and an ability to structure and finance complex deals. In addition, private credit financing is fast becoming an alternative to equity financing globally, primarily for firms that do not want further equity dilution and find the flexible approach of private credit more attractive.

TRENDS IN JAMAICAN CREDIT LANDSCAPE

Shortly after Jamaica's second IMF agreement in three years, Bank of Jamaica data revealed that distribution of credit to the private sector in December 2013 was 37 per cent to business loans vs 63 per cent to personal loans.

In fact, personal loans had long dominated the distribution of credit in Jamaica.

Fast-forward to December 2017 and the impact of Jamaica's fiscal prudence on the credit sector revealed an improving story: business loans represented 56 per cent of credit vs 44 per cent for personal loans, thus setting the platform for a more sustainable growth path, albeit slow.

In addition, the latest Bank of Jamaica data revealed that credit to the private sector grew 31 per cent in the 12 months through February 2017 to $484 billion versus a growth of 4.3 per cent in the 12 months through February 2014.

Despite this recent growth in credit to the private sector, midsized companies will need a greater mix of flexible capital sources in the years ahead to meet the demand for opportunities, which require non-bank financing, as Jamaica becomes a stronger regional player.

Medium-sized firms typically contribute a substantial portion (for SMEs, up to 60 per cent of total employment and up to 40 per cent of GDP) to employment and GDP in emerging market economies such as Jamaica.

Jamaica's private credit market is currently estimated at a paltry US$100 million, representing less than three per cent of the non-government credit market, which is not enough to stimulate the right amount of economic activity among medium-sized firms.

This is in stark contrast to more developed markets such as the United States, where private credit plays a substantial complementary financing role, especially for medium-sized firms.

Thus, the development of the private credit market in Jamaica and the wider region at this time would be a welcome development as the country seeks higher levels of growth.

Private credit has the potential to stimulate economic activity by diversifying the supply of credit, improving the blend and overall resilience of different funding sources, and drive stronger growth and profitability in medium-sized firms.

Jason Morris CFA, JP is the chief investment officer and head of investment management at SYGNUS Capital. He can be contacted at:

jason@sygnuscapital.com

or www.sygnusgroup.com.


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